The Attack on Generic Profits in Drug Channels

Today’s Wall Street Journal has a very good overview of key issues for the generic industry, such as biogenerics and the FDA’s generic approval process. See Democrats’ RX? Generics.

However, I wonder if this renewed political focus on generics will ultimately reduce the profits of pharmacy chains and wholesalers. Companies that could be affected include CVS Corp (CVS), Walgreens (NYSE WAG), and McKesson Corp (MCK), to name just a few.

As faithful readers of this blog know, the supply chain – wholesalers, retail pharmacies, and mail order – get a larger share of total prescription drug revenue from generics. Profits on generic drugs now subsidize the retail and wholesale distribution of much more expensive branded products. (See my May post Will unbundling crush pharmacy profits?).

How profitable are generics? For fun (?), I went back to the 2004 CBO report Medicaid’s Reimbursements to Pharmacies for Prescription Drugs, which studied Gross Profits per Script (GPS) for pharmacies under the Medicaid system. Note that the study refers to GPS as “markups” and excludes any co-payments received from patients.

Gross Profit Per Script for Pharmacies in Medicaid (2002)

• Brand-name Drugs = $13.80 (14%)
• Older Generic Drugs (pre-1997 launch) = $9.90 (70%)
• Newer Generic Drugs (1997 to 2002) launch = $32.10 (70%)

In other words, filling a generic Medicaid prescription earned a pharmacy $18.30 more per script in 2002. These data come from 2002, so they go a long way to explaining why the new Federal Upper Limit for generic reimbursement under Medicaid will shift to Average Manufacturer Price (AMP) + 250% rather than an AWP-minus model. (See McClellan and the Magic AMP and AWP Ain’t What Matters for background.)

The channel's genertic profits are also under visible attack in the minds of consumers. As I pointed out yesterday, Wal Mart Stores Inc (WMT) is aiming at the pharmacy industry’s weak spot, encouraging pharmacies to argue that consumers should ignore price. (See Wal-Mart Raises the Stakes.)

But let's not forget that these profit margins provide powerful incentives for generic substitution by the channel, which has in turn lowered drug spending by employers and the government. Key scenario questions that I am now considering with my clients:

1. How will manufacturers and payers manage the costs of getting products from the factory to the patient?
2. What will happen to the retail and wholesale channel if generic margins come down?
3. What parts of the supply chain will retain reasonable profit opportunities?

Hey, I’m just one voice out there, so please don’t forget Newton’s Second Law of Consulting: For every expert, there is an equal and opposite expert.

Have a Happy Thanksgiving!